Dave Sather's Money Matters: Should you invest in Facebook?

Currently, Facebook is a privately held company. However, if you had the opportunity to own some shares, should you?

Investors can act upon this decision sometime in 2012 as Facebook has its Initial Public Offering.

Last week, it was announced that Goldman Sachs took a private ownership position in Facebook, the online social networking company that has nearly 600 million users.

This transaction gives us a small glimpse inside the financial aspect of Facebook, which valued the entire entity at a whopping $50 billion. At that size, it has about the same value as Boeing, Kraft Foods or American Express.

With this release came a bit of leaked financial data from Goldman to some of its wealthy customers. For the first nine months of 2010, Facebook had revenues of $1.2 billion and net profits of $355 million, or around $500 million for the full year.

This is truly amazing for a 7-year-old company.

When valuing any company, the value comes from the long-term total of its earnings.

If Facebook succeeded in earning $500 million last year, then that would put its value at 100 times its earnings (also known as its price-to-earnings multiple).

That is a pretty astounding figure, one that we have not seen since the last tech/Internet bubble.

For 2011, Facebook is projected to earn between $800 million and, possibly, $1 billion. Even with that amazing growth, it would still trade for 50 to 60 times its earnings based on the $50 billion price tag for the entire company.

Compare this to companies such as Google, Apple or Microsoft. Google is now 10 years old and trades for 25 times its earnings; Apple trades for 22 times its earnings. Microsoft, the granddaddy of the tech companies, is considered a relative bargain at 12 times its earnings.

That is the dilemma investors will face (no pun intended). Does Facebook currently deserve to be valued at more than double the earnings multiple of Google or Apple? Is Facebook, as a company, four or five times better and more profitable than Microsoft?

That is a pretty tall order for the friends at Facebook.

Henry Blodget, with Business Insider, said for Facebook to grow into this already steep valuation, it would need to double its earnings from $500 million in 2010 to $1 billion in 2011.

The company will need to again double its earnings to $2 billion in 2012 so they can trade at a similar level to Google.

It is obvious Facebook is growing rapidly. However, at some point, the Law of Large Numbers, as it relates to finance, will catch up to the company and its growth will slow. Investors need to be careful about overpaying for this growth.

Facebook also reminds me of an interview with Warren Buffett in which Buffett stated that just because something has the ability to transform society, does not make it a good investment. Buffett went on to make his point by discussing the invention of the car, air travel and the Internet.

These all transformed society immensely, but mostly proved to be horrible investments.

Given these issues, Facebook is already priced richly. Although it may grow into these projections, investors wanting to jump on the Facebook bandwagon should proceed with caution.

Dave Sather is a Victoria certified financial planner and owner of Sather Financial Group. His column, Money Matters, publishes every other Wednesday.